Yahoo's Cautious Course

How Now 'Sacred Cow'?
Lack of Major Overhaul Poses Test

By

Kevin J. Delaney

Updated Sept. 10, 2007 12:01 a.m. ET

Investors who have grown impatient with Yahoo Inc.YHOO-2.00% may have to wait awhile longer to see any pop in its stock.

The Internet company replaced its chief executive in June and this summer kicked off a strategic review to better position it for a changing online-advertising market and compete with the likes of Google Inc.

July 17: Mr. Yang says will spend roughly 100 days mapping out a long-term strategic plan

Aug. 29: Yahoo reorganizes, shuffles responsibility for ad sales

Now, partway through Yahoo's strategic soul-searching, people familiar with the matter say a major overhaul appears unlikely.

When the Sunnyvale, Calif., company announced lower second-quarter profit and dropped its 2007 forecasts in July, co-founder and new CEO Jerry Yang told analysts that he planned to spend roughly the next 100 days crafting a long-term strategic plan and making any necessary changes to the company's staff and organization.

In recent years, Yahoo has been eclipsed by the success of Google's search-advertising-fueled growth, faced criticism for a lack of management focus, fumbled some opportunities to capitalize on the latest high-growth Internet areas such as video and social networking and saw its revenue-growth rate fall as advertisers expanded their online spending on other sites.

Its share price has dropped about 15% in the past 12 months and in 4 p.m. composite trading Friday on the Nasdaq Stock Market, the stock was down 1.6%, or 39 cents, to $23.76.

"There will be no sacred cows, and we need to move quickly," Mr. Yang said in July. He promised a progress report this fall and then ducked out of public sight, declining even to give the standard postearnings media interviews.

The people familiar with the matter say that over the summer, Mr. Yang did actively assess one major sacred cow: the Web-search-advertising business it built up at great expense in recent years. Under the scenario discussed by top executives, Yahoo would have outsourced that search-advertising activity -- which places small text ads next to Web search results -- to either Google or Microsoft Corp.MSFT-0.38%, the people say. One of these people says Yahoo raised the idea with Google.

Such a move would likely give Yahoo an immediate revenue bump representing hundreds of millions of dollars annually, because Google, for one, generates about 40% more revenue for each consumer search than Yahoo, according to Majestic Research Corp. in New York. It could also bring in additional one-time payments from any outsourcing partner and would reduce some of Yahoo's operations costs and capital spending.

But one of the people familiar with the matter says Mr. Yang concluded that Yahoo needed to be the "marketing operating system," providing advertisers with a full menu of online-ad options. Yahoo would have a hard time doing so if it outsourced search advertising, which represents roughly 40% of the U.S. online-ad market, one person says. Any discussion of outsourcing search ads has now cooled, the people familiar with the situation say.

The dim prospects for such a major strategic change have tested some investors' patience. "After meeting with management in August, we decided that the management isn't considering the kind of transformational changes that would be required to improve their position in the market," says Glen Kacher, managing director of Menlo Park, Calif., investment fund Integral Capital Partners, which has more than $500 million under management.

Mr. Kacher, who believes that outsourcing search advertising could tap "massive earnings power," said Integral sold its entire Yahoo holdings following the mid-August meeting with Yahoo President Susan Decker and Chief Financial Officer Blake Jorgensen. He declined to specify the amount of those holdings.

"Jerry Yang and Sue Decker are committed to making significant changes to the way Yahoo operates, and to sharpening its focus on key initiatives that will enable the company to improve its performance and strengthen its position as the most open, vibrant online marketplace for consumers, advertisers and publishers," said a company spokeswoman in a statement.

In the absence of bold strokes, Mr. Yang's other moves are likely to seem much more mundane. The company has hired San Francisco consulting firm Stone Yamashita Partners to help guide its strategic deep-thinking and bring its new management team together. Top executives have convened for Friday off-site meetings over the summer and joined committees on issues such as corporate culture as part of that strategy-consulting process.

The people familiar with the matter say Mr. Yang has internally played down the significance of the 100-day timeline and that no big strategic announcements are planned at the end of that period next month.

Other likely outcomes from Yahoo's process: The company slims down some of its activities. Its Yahoo Music service, which has about 250 to 300 staff, is among those expected to be trimmed and its fee-based subscription music offering overhauled or shuttered. Overall, the company plans to move staff around and freeze some positions, though significant layoffs aren't expected, people familiar with the matter say.

Some expect Mr. Yang to increase available resources to activities that attract users from the outside, such as the home page, email and its finance-information site, as opposed to activities such as its news site, which are more reliant on people linking there from other parts of Yahoo.

Yahoo executives have been signaling that it plans to add social-networking features to its popular email service as a way to increase use. Yahoo Mail, with about 250 million users, is "one of the Web's largest dormant social networks and one that we are aggressively pursuing ways to activate," Ms. Decker told analysts during a postearnings conference call in July.

Some other changes already have been announced, such as the ascension of former Knight-Ridder executive Hilary Schneider to oversee advertising sales and the combination of Yahoo's search and graphical-display-ad sales teams. Yahoo last Tuesday announced plans to buy online-ad network BlueLithium for $300 million, in a further move to extend its display-advertising reach online.

Some investors are still holding out hope. They believe that there is little long-term downside to investing in Yahoo. The anticipated changes -- and a greater focus on operational execution -- could eventually yield financial improvements.

The long-awaited overhaul to its search-advertising system, dubbed Project Panama, is boosting the amount of revenue it generates for each consumer search. Yahoo's 463 million users world-wide at the end of last quarter represent a massive audience it can tap for ad dollars.

Others are betting on a deal. In that scenario, these investors believe, the shares will slide and become cheap enough to attract an acquirer willing to pay a significant premium to the current price. Mr. Peck highlighted a possible deal premium as a factor in reiterating his "outperform" rating on the shares and cited Microsoft as a potential Yahoo acquirer.

Yahoo in recent years has had conversations of varying intensity with Microsoft, Time Warner Inc., News Corp. and eBay Inc. about combining at least some of their activities, without reaching any deal, people familiar with the matter say. Such talks don't appear to be currently active, says one person familiar with the matter.

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